Thomas Hoenig: In the short term, I suspect we're going to have a great deal of volatility and uncertainty as we try and figure out what's going to happen.
On the fiscal side, Congress could continue to have stalemates on the debt ceiling as debt continues to grow. On the monetary side, the Federal Reserve (Fed) has committed to maintaining interest rates higher for longer until they get that inflation number down closer to 2%.
So, it's going to be choppy as we go forward from here for the next several weeks or months.
Thomas: I suspect the bond market will be also volatile and we'll see yields go up. We're seeing that now, and it’s partly due to fiscal policy being in shambles.
Interest on US debt will also continue to explode. The Fed is in a position of quantitative tightening, and they're promising to hold to that for the foreseeable future. This means that rates should go up, and we'll see downward pressure on asset values as they do so.
I am concerned about it, but it’s what the Fed has to do.
Thomas: The effect on asset values will be downward pressure.
"We can also expect quantitative tightening as this process continues, given the amount of new debt that the Treasury has to raise. It’s a substantial amount."
The politics of that is there will be pushback. We’ll see how strong the Fed – and its commitment to getting inflation down – is. This is a situation we need to anticipate going forward.
We can also expect quantitative tightening as this process continues, given the amount of new debt that the Treasury has to raise. It’s a substantial amount – close to a trillion dollars. There is also the debt that will turn over, which means we will see upward pressure on the yield curve, including the long end.
Ultimately, this all means asset values will be under pressure.
Thomas: The first thing I would say is that the current situation is probably not sustainable.
Something will need to be done with fiscal policy. It’s exploding. The pressure for funding means upward pressure on interest rates – and it also means more pressure on the Fed to back off its rate hiking policy to bring inflation down to 2% sooner rather than later.
"There will likely be a standoff between the fiscal authorities – wanting to issue more debt and not raise taxes and not cut spending – and the Fed."
These are enormous pressures on the Fed, and the fiscal side wants renewed inflation – which would reduce the real value of its debt. So therein lies a future problem.
I suspect there will likely be a standoff between the fiscal authorities – wanting to issue more debt and not raise taxes and not cut spending – and the Fed, which will insist on keeping rates high and keeping tightening in place to keep inflation under control.
This all makes for a difficult situation.
